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UC-NRLF 


$B    ^5    lb? 


Depletion  of  Mines  in  Relation 
to  Invested  Capital 


A  paper  read  at  Conference  on  Mine  Taxation, 
Annual  Convention  of  the  American  Mining 
Congress,  Denver,  Colorado,  November  i6,  1920 


Wm.B.Gower,  C.P.A. 

Member  American  Institute  of  Accountants 

20  Exchange  Place 

New  York 


'IFT 


THE  LIBRARY 

OF 

THE  UNIVERSITY 

OF  CALIFORNIA 

HENRY  RAND  HATFIELD 
MEMORIAL  COLLECTION 


PRESENTED  BY 

FRIENDS  IN  THE  ACCOUNTING 

PROFESSION 


HENl 

^HRKELEy     CALIF< 


Depletion  of  Mines  in  Relation 
to  Invested  Capital 

In  the  system  of  Federal  taxation  adopted  in  1917 
and  continued  since  for  the  purpose  of  raising  the  im- 
mense sums  required  by  the  war  emergency,  the  concept 
of  invested  capital  plays  a  most  important  part.  The 
definition  of  invested  capital,  in  both  the  Revenue  Acts  of 
1917  and  1918,  has  encountered  much  criticism  because 
it  rejected  present  day  valuation,  and  substituted  for  such 
real  values  an  artificial  concept.  Not  only  that:  but  this 
artificial  concept  of  invested  capital  is  rendered  more 
diflicult  by  reason  of  its  expression  through  the  medium 
of  accounting  ideas  and  terminology.  Accounting  is  not 
an  exact  and  settled  science,  and  accounting  principles  and 
practice  involve  many  uncertainties,  many  disputed  ques- 
tions, and  many  divergent  usages,  customs  and  methods. 
The  mining  industry  has  had  its  share,  and  perhaps  more 
than  its  share,  of  these  disputed  questions  relating  to 
invested  capital.  None  of  these  questions,  however,  has 
been  more  disputed  than  the  proper  adjustment  of  the 
original  basic  invested  capital  of  a  corporation  engaged 
in  mining,  which  is  required  by  reason  of  removal  of 
minerals  from  the  property  from  the  commencement  of 
operations  down  to  the  taxable  year.  The  question,  con- 
cisely expressed,  is  as  to  the  effect  of  depletion  upon  in- 
vested capital. 

For  the  purpose  of  this  adjustment  of  the  invested 
capital  of  a  mining  corporation,  the  bureau  of  internal 
revenue  has  adopted  a  basic  principle  and  rule  which  has 
encountered  unanimous  dissent  and  opposition  from  the 
mining  corporations  to  which  it  has  been  applied.  The 
occasion  is  opportune,  therefore,  to  examine  this  rule,  to 
show  its  workings,  and  to  expose  its  fundamental  error. 
Inasmuch  as  the  rule  rests  primarily  upon  accounting 
propositions,  the  burden  of  refuting  the  rule  depends 
mainly  upon  accounting  considerations.     The  present  dis- 


cussion  Is  confined  largely  to  these  considerations,  leaving 
the  strictly  legal  and  statutory  objections  to  the  rule  for 
later  discussion  by  others. 

The  broad  principle  underlying  the  rule  adopted  by 
the  bureau  Is  that  every  unit  of  mineral  removed  from  a 
mining  property  from  the  commencement  of  operations 
down  to  the  taxable  year  impairs  the  original  cost-value 
or  original  invested  capital  value  of  the  mine,  at  a  con- 
stant rate  per  unit,  necessarily.  Invariably,  and  regard- 
less of  actual  conditions,  facts  and  valuation  of  the 
mining  property.  The  bureau  declares  that  its  rule  rests 
upon  accounting  principles  established  for  the  computation 
of  the  surplus  and  undivided  profits  of  mining  corpora- 
tions.    The  formal  declaration  Is  as  follows: 

Art.  839.  Surplus  and  Undivided  Profits:  Allow- 
ance for  Depletion  and  Depreciation. — Depletion, 
like  depreciation,  must  be  recognized  In  all  cases  In 
which  It  occurs.  Depletion  attaches  to  each  unit  of 
mineral  or  other  property  removed,  and  the  denial 
of  a  deduction  In  computing  net  Income  under  the 
Act  of  August  5,  1909,  or  the  limitation  upon  the 
amount  of  the  deduction  allowed  under  the  Act  of 
October  3,  1913,  does  not  relieve  the  corporation  of 
its  obligation  to  make  proper  provision  for  depletion 
of  Its  property  in  computing  its  surplus  and  undivided 
profits. 

In  order  that  we  may  visualize  and  understand  this 
rule  clearly.  It  is  well  to  Illustrate  by  an  actual  case  and 
definite  figures.  The  company  referred  to  owns  and 
operates  a  large  copper  mining  property  in  Arizona.  It 
was  incorporated  twenty  years  ago  with  a  capital  of 
$3,000,000,  although  at  the  time  of  incorporation  the 
mine  was  worth  many  times  this  nominal  capitalization. 
Under  the  treasury  regulations  administering  the  excess 
profits  tax  law  of  1917  the  company  was  allowed  to 
establish  the  value  of  the  ore  bodies  definitely  known  to 
exist  at  the  time  of  Incorporation  in  the  year  1900,  In 
order  that  the  excess  of  this  value  over  the  aggregate 
par  of  the  shares  of  stock  issued  for  the  property  might 
be  included  in  invested  capital  as  paid-in  surplus.  It  was 
established  that  the  commercial  value   of  the  ore  bodies 


definitely  known  to  exist  at  that  time  was  at  least  $26,- 
500,000,  and  this  sum  was  allowed  as  the  basic  invested 
capital  of  the  company. 

During  the  period  from  January,  1900  to  March  1, 
1913,  this  company  mined  about  400  million  pounds  of 
copper,  and  simultaneously  developed  a  much  greater 
quantity  by  extensions  of  its  ore  bodies.  The  value  of 
the  mining  property  at  March  1,  1913,  was  fixed  by 
the  Valuation  Unit  of  the  bureau,  for  purposes  of  deple- 
tion, at  $41,500,000.  Between  March  1,  1913  and  the 
beginning  of  the  taxable  year  1917  the  company  mined 
about  200  million  pounds  of  copper,  equivalent  to  about 
one-fifth  of  the  quantity  estimated  to  be  in  the  property  on 
March  1,  1913. 

At  the  beginning  of  the  taxable  year  1917  the  company 
had  an  accumulation  of  surplus  earnings,  in  excess  of 
$16,000,000,  derived  mainly  from  the  operation  of  its 
mining  property. 

Under  the  rule  adopted  by  the  bureau,  it  is  claimed 
that  this  company's  invested  capital  for  the  taxable  year 
1917  should  be  reduced  by  over  $11,000,000  for  alleged 
impairment  of  the  original  paid-in  capital  of  $26,500,000. 
This  deduction  of  $11,000,000  from  the  invested  capital 
was  reached  by  multiplying  the  number  of  pounds  of 
copper  mined  during  the  seventeen  years  between  January, 
1900  and  December,  1916  (approx.  600  millions)  by  a 
constant  unit  rate  of  1.8457  cents  per  pound.  This  unit 
rate  was  obtained  by  dividing  the  original  capital  value  of 
the  mine  ($26,500,000)  by  the  number  of  pounds  of 
copper  estimated  to  have  been  in  the  mining  property  in 
1900,  based  upon  the  figures  available  as  of  March  1, 
1913. 

We  see  then,  by  the  actual  case  above  cited,  that  the  ^ 
administrative  rule  adopted  by  the  bureau  is  based  upon 
the  proposition  that,  although  the  commercial  value  of  the 
mining  property  increased  during  the  17  year  period  by 
nearly  50%,  it  is  necessary  to  deduct  $11,000,000  from 
the  invested  capital  in  order  to  recognize  impairment  of 
the  original  invested  capital  value  of  the  mining  property, 
which  is  regarded  as  having  occurred  during  this  identical 
period.      By  this   rule   $11,000,000   of   actual  profits   are 


deducted  in  order  to  recognize  an  impairment  of  original 
commercial  value  which  is  wholly  imaginary. 

We  have  seen,  by  the  citation  heretofore  made  from 
the  regulations,  that  the  bureau  justifies  its  rule  by  de- 
claring that  it  represents  a  fundamental  accounting  prin- 
ciple in  the  computation  of  surplus  and  undivided  profits 
of  mining  corporations.  The  bureau  contends  that  its 
rule  embodies  a  permanent  and  established  profit  account- 
ing rule  for  mines.  It  must  be  remembered  that  invested 
capital  consists,  broadly  speaking,  of  two  main  elements; 
first,  the  original  paid-in  capital;  second,  the  accumulated 
surplus  earnings.  It  was  open  to  the  bureau,  in  making 
its  rule  for  the  recognition  of  the  efiect  of  depletion  upon 
invested  capital  of  mining  corporations,  to  attack  the  first 
element,  the  paid-in  capital.  The  bureau  decided,  how- 
ever, against  this  course,  and  concentrated  its  attention 
upon  the  second  element  of  invested  capital,  namely,  the 
surplus  earnings.  It  is  most  important  to  keep  in  mind 
that  the  bureau's  rule  is  an  attack  on  the  status  of  the 
surplus  earnings,  and  its  justification  is  proclaimed  as 
resting  upon  an  established  profit  accounting  rule  for 
mines.  It  makes  no  difference  that  the  surplus  earnings 
may  have  been  distributed  as  dividends:  for  the  attack 
is  then  merely  diverted  to  the  paid-in  capital,  on  the 
ground  that  the  amounts  so  distributed  were  not  wholly 
"profits"  but  included  a  partial  liquidation  of  such  capital. 

It  becomes  important,  therefore,  to  arrive  at  a  correct 
understanding  of,  and  to  reaffirm,  certain  established 
accounting  rules  which  are  fundamental  in  determining 
the  true  profits  of  mining.  (We  are  not  now  referring 
to  the  ascertainment  of  present-day  taxable  income  from 
mines,  but  to  true  profits,  which  is  an  entirely  different 
affair.)  The  bureau  has  decided  that  profits  of  mining 
computed  during  a  generation  past  pursuant  to  our 
accepted  accounting  rules  were  incorrectly  computed;  that 
the  custom  was  unsound,  and  the  teaching  of  the  ac- 
countancy manuals  on  the  subject  of  mining  profits  at 
fault.  It  has  decided  that  the  profits  from  mining  during 
these  bygone  years  must  be  recomputed  under  a  new  set 
of  accounting  rules  which  the  mining  industry  never 
thought  of  adopting  in  those  days,  which  it  has  not  adopted 


today,  and  which  may  never  be  accepted.  The  bureau 
has  decided  that  the  undistributed  mining  profits,  whether 
accumulated  recently  or  accumulated  over  a  long  term 
of  years  must  be  adjusted  to  conform  to  new  ideas. 

The  practical  effect  of  all  this  procedure  is  to  attack  the 
status  of  the  surplus  earnings  of  mining  corporations  shown 
by  their  books  and  accounts,  an  authorized  element  of  in- 
vested capital  in  the  profits  tax  laws  of  1917  and  1918. 
By  means  of  this  procedure  the  mining  corporations  have 
been  deprived  of  scores  of  millions  of  dollars  of  invested 
capital,  and  their  profits  taxes  increased  correspondingly. 

The  hypothesis  upon  which  the  bureau  has  proceeded  is 
that  no  reckoning  of  the  true  profits  of  mining,  past,  pres- 
ent and  future,  is  valid  unless  a  portion  of  each  yearns 
revenues  is  assigned  towards  the  wiping  out  of  the  original 
cost  or  the  original  capital  value  of  the  mining  property. 
The  underlying  principle  is  declared  to  be  that  depletion 
of  the  original  cost  or  original  capital-value  attaches  to 
each  unit  of  mineral  removed,  at  a  constant  rate  per  unit. 
The  method  relied  upon  is  to  provide  annually  such  pro- 
portion of  the  original  cost  or  original  capital  value  of  the 
mine  as  the  year's  output  of  minerals  bears  to  the  total  es- 
timated original  mineral  contents  of  the  mine.  This 
formula  is  considered  to  apply  to  all  mineral  deposits 
regardless  of  the  actual  condition  and  value  of  the  mine 
at  the  end  of  the  accounting  period.  The  formula  is  con- 
sidered to  apply  to  all  mineral  deposits  without  regard  to 
any  restoration  of  the  ore  reserves  comprehended  in  the 
original  cost  or  original  capital  value  which  may  have  re- 
sulted from  exploration  and  development  work  carried  on 
contemporaneously  with  extraction  and  removal  of  miner- 
als. The  formula  is  considered  to  apply  to  all  mineral 
deposits  even  though,  as  is  usually  the  case,  it  is  impossible 
to  estimate  the  original  mineral  contents  of  the  mine  with 
any  degree  of  accuracy,  until  most  of  the  contents  have 
been  removed. 

It  is  possible  that  for  a  certain  small  class  of  mining 
properties  this  hypothesis  adopted  by  the  bureau  embodies 
a  logical  method  for  determining  the  true  profits  from  min- 
ing, whether  past,  present  or  future.  The  small  class  of 
mines  referred  to  contains  deposits  in  which  the  character 


and  extent  of  the  valuable  content  is  known  and  determin- 
able at  the  time  of  acquirement,  and  forms  the  basis  of  the 
purchase.  But,  for  the  great  bulk  of  mining  properties,  In 
which  the  character  and  extent  of  the  valuable  content  can- 
not be  determined  with  any  degree  of  certainty  until  many 
years  have  elapsed,  the  method  is  neither  logical  nor 
practicable. 

It  is  not  germane  to  the  question,  however,  how  far  the 
bureau's  hypothesis  and  method  may  be  defended  on  logical 
grounds,  and  by  a  priori  reasoning.  The  question  Is  not  a 
speculative,  but  a  practical,  one;  not  what  ought  to  he  the 
rule  for  testing  the  true  profits  of  mining,  but  what  is.  The 
mining  corporations  whose  surplus  earnings  are  attacked 
as  an  element  of  Invested  capital  to  the  extent  of  millions 
of  dollars;  who  are  now  told  that  during  all  these  years 
their  books  and  accounts  have  been  kept  incorrectly;  that 
their  true  profits  have  been  wrongly  computed  each  year 
by  hundreds  of  thousands  of  dollars,  and  that  their  ac- 
countants were  wandering  in  darkness,  will  require  a  good 
deal  of  convincing.  They  will  scarcely  be  consoled  for 
their  loss  when  the  bureau  tells  them  that  the  long-pre- 
vailing rules  under  which  mining  profits  were  reckoned 
were  unsound  and  invalid;  that  while  such  rules  were  the 
basis  of  all  profit  accounting  required  by  legislatures,  courts 
and  business  men,  nevertheless  they  were  erroneous  In 
principle  and  method;  and  that  it  Is  time  to  revise  all  this 
profit  accounting  of  past  years  and  put  it  on  a  correct  foun- 
dation. For  it  seems  that,  according  to  the  bureau,  these 
profit  accountings  of  past  years  were  tainted  with  an  ele- 
ment of  original  capital;  and  this  element  of  original  capi- 
tal is  to  be  removed  by  actuarial  calculations  of  "pure" 
income,  so  that  no  trace  shall  remain.  True,  the  original 
cost  or  capital-value  of  the  mineral  deposit  may  be  wholly 
Intact,  and  the  mine  operator  unable  to  understand  why  he 
must  provide  out  of  his  profits  for  the  "recovery"  of  some- 
thing which  he  has  not  lost.  True,  also,  this  "recovery"  Is 
to  be  figured  by  means  of  mathematical  computations  rest- 
ing upon  very  uncertain  and  variable  data.  Apparently, 
however,  the  perfection  and  durability  of  the  logical  and 
actuarial  structure  does  not  depend  upon  its  very  sandy 
foundation. 


The  fact  is  that  the  reckoning  of  the  profits  from  mining 
is  distinguished  by  a  peculiar  principle  and  by  special  rules 
which  have  been  recognized  during  a  long  term  of  years 
not  only  by  the  lay  mind,  but  by  legislators,  by  the  courts 
and  by  accountants,  and  which  are  totally  at  variance  with 
the  bureau's  hypothesis.  It  is  important  not  only  to  under- 
stand this  peculiar  principle  and  these  special  rules  for  de- 
termining the  periodic  true  gains  or  losses  from  mining, 
but  also  to  realize  that  they  were  confirmed  by  the  au- 
thority of  a  memorable  group  of  decisions  of  the  Supreme 
Court,  which  settled  the  questions  once  and  for  all.  The 
leading  case,  Stratton^s  Independence  V.  Howhert  (231 
U.  S.,  399),  was  decided  in  December,  1913,  and  the  sub- 
sequent cases  in  the  group  at  various  times  in  1916,  1917 
and  1918,  upon  the  principles  upheld  in  the  Stratton  case. 
It  is  equally  important  to  bear  in  mind  that  nothing  in 
recent  tax  legislation  has  impaired  the  validity  of  the  prin- 
ciples upheld  by  the  court  in  these  cases,  and  that  the  true 
profits  and  losses  from  the  operations  of  mining  property 
(as  distinguished  from  present  day  net  taxable  income) 
must  be  reckoned  today  by  the  same  principles. 

Before  considering  the  fundamental  principles  upon 
which  the  accounting  rules  for  determining  the  true  profits 
of  mining  rest,  it  is  necessary  to  explain  the  three  peculiar 
characteristics  of  mining  which  have  caused  the  accounting 
practice.  They  have  been  stated  concisely  and  lucidly  by 
the  Supreme  Court  in  the  leading  case: 

"The  peculiar  character  of  mining  property  is  suffi- 
"ciently  obvious.  Prior  to  development  it  may  pre- 
"sent  to  the  naked  eye  a  mere  tract  of  land  with 
"barren  surface,  and  of  no  practical  value  except  for 
"what  may  be  found  beneath.  Then  follow  excava- 
"tion,  discovery,  development,  extraction  of  ores,  re- 
"sulting  eventually,  if  the  process  be  thorough,  in  the 
"complete  exhaustion  of  the  mineral  contents  so  far 
"as  they  are  worth  removing.  Theoretically,  and  ac- 
"cording  to  the  argument,  the  entire  value  of  the 
"mine,  as  ultimately  developed,  existed  from  the  be- 
"ginning.  Practically,  however,  and  from  the  com- 
"mercial  standpoint,  the  value — that  is,  the  exchange- 
"able  or  market  value — depends  upon  different  con- 
"siderations.  Beginning  with  little,  when  the  exist- 
"ence,  character  and  extent  of  the  ore  deposits  are 

7 


"problematical,  it  may  increase  steadily  or  rapidly 
"so  long  as  discovery  and  development  outrun  de- 
"pletion,  and  the  wiping  out  of  the  value  by  the  prac- 
"tical  exhaustion  of  the  mine  may  be  deferred  for  a 
"long  term  of  years." 

{Stratton^s     Independence     V.     Howbert,     231 
U.  S.,  399.) 

ex  Thus  we  see  that  the  three  peculiar  features  which  have 

determined  the  special  accounting  rules  are  (1)  the  im- 
possibility of  determining  the  existence,  character  and  ex- 
tent of  the  ore  bodies  until  many  years  have  elapsed;  (2) 
the  distinction  between  the  original  cost  or  original  com- 
mercial value  of  the  mine,  and  the  true  intrinsic  or  latent 
value  ultimately  disclosed  by  exploration  and  development; 
and  (3)  the  fact  that  removal  of  minerals  does  not  neces- 
sarily imply  a  shrinkage  in  the  original  cost  or  original 
commercial  value  of  the  mining  property;  on  the  contrary, 
the  commercial  value  may  increase  coincidently  with  re- 
moval of  minerals  by  reason  of  discovery  and  development 
outrunning  depletion. 

Out  of  these  peculiar  characteristics  there  arose  special 
rules  in  the  reckoning  of  profits  from  mining  differing 
sharply  from  the  rules  for  ascertaining  the  profits  of  com- 
mercial enterprises  generally: 

First:  In  the  reckoning  of  earnings  from  mines,  the  en- 
tire revenues  derived  from  mining  constitute  income  and 
profits,  without  any  deduction  whatever  for  original  cost 
or  original  commercial  or  market  value  of  the  mineral 
deposit,  as  the  case  may  be.  The  wiping  out  of  the  origi- 
nal cost  or  commercial  value,  through  the  exhaustion  of  the 
mine,  is  considered  and  booked  as  a  loss  of  capital,  and  is 
entirely  separate  and  distinct  from  a  loss  of  profits. 

The  cost  or  the  commercial  value  of  ore  or  minerals 
removed  during  the  operation  of  a  mining  property  may 
not  be  booked  in  the  accounts  as  an  ordinary  and  neces- 
sary expense  of  mining,  nor  as  part  of  the  cost  of  goods 
sold,  nor  as  depreciation,  nor  as  a  charge  against  profit  or 
loss,  directly  or  indirectly. 

Second:  The  foundation  of  the  mine  accounts  is  the 
original  cost  of  the  mineral  deposit  if  acquired  for  cash,  or 

8 


POSTSCRIPT 

The  discussion  at  Denver  upon  the  relation  of  deple- 
tion of  mines  to  invested  capital  which  took  place  in 
the  Conference  on  Mine  Taxation  after  the  reading  of 
this  article,  resulted  in  the  adoption  by  the  American 
Mining  Congress  of  the  following  resolution: 

"Whereas,  the  Bureau  of  Internal  Revenue,  having  under 
the  1909  Tax  Law  contended  that  the  net  proceeds  of 
mines  constituted  profits  and  were  all  taxable  without  any 
deduction  for  depletion,  basing  such  contention  on  the 
general  practice  of  the  mining  industry  at  that  time,  and 
having  succeeded  in  establishing  that  view  in  the  courts, 

"Be  it  resolved,  that  it  is  the  sense  of  this  Congress  that 
the  rule  now  adopted  by  the  Bureau  of  Internal  Revenue 
in  ascertaining  the  invested  capital  of  mining  corporations 
by  which  a  deduction  is  made  from  profits  for  each  unit  of 
minerals  removed  since  the  commencement  of  mining 
operations  down  to  the  year  1916,  regardless  of  actual  con- 
ditions, actual  facts  and  valuations  of  the  mining  property, 
is  inconsistent  and  unfair;  and, 

"It  is  further  resolved,  that  this  Congress  take  steps  to 
present  its  reasons  to  the  Bureau  of  Internal  Revenue 
supporting  an  abrogation  of  such  rule." 

New  York,  Nov.  22,  1920. 


its  exchangeable  or  market  value  if  acquired  in  exchange 
for  stock  of  the  purchasing  company.  When  any  shrink- 
age or  impairment  of  this  original  cost  or  original  com- 
mercial value  occurs,  it  should  be  entered  in  the  accounts 
as  a  loss  of  capital.  Such  shrinkage  or  impairment  is  a 
question  of  fact,  which  can  be  established  only  by  means 
of  a  valuation,  and  which  depends  mainly  upon  the  charac- 
ter and  extent  of  the  delimited  ore  reserves  in  the  mine  at 
the  date  of  acquisition,  and  at  the  date  of  valuation. 

So  long  as  the  commercial  value  of  the  mine  is  at  least 
equal  to  its  original  cost  or  original  commercial  value;  and 
so  long  as  the  known  ore  reserves  are  at  least  equal  in 
character  and  extent  to  those  known  originally,  the  ac- 
counts do  not  provide  for  the  wiping  out  of  the  original 
cost  or  original  commercial  value. 

The  removal  of  minerals  from  a  deposit  implies  a 
shrinkage  of  economic  or  intrinsic  capital-value,  but  does 
not  necessarily  or  even  usually  connote  a  shrinkage  of 
original  cost-value  or  original  commercial-value,  for  fre- 
quently the  removal  of  minerals  is  offset  by  discovery  and 
development  of  ore  bodies  not  previously  known  and  de- 
limited. The  shrinkage  of  economic  or  theoretical  capital- 
value,  as  distinguished  from  impairment  of  original  cost- 
value  or  original  commercial-value,  is  not  recognized  in 
mine  accounts. 

I. 

One  of  the  chief  difficulties  in  determining  profits  arises 
in  connection  with  writing  off  or  amortizing  the  capital 
value  of  assets  which  waste  in  the  process  of  producing 
income,  but  which  may  last  over  a  long  period  of  years. 
The  assets  referred  to  may  be  regarded  generically,  as 
sources  out  of  which  income  emerges;  not  only  inherently 
wasting  material  assets  such  as  plant,  machinery,  buildings, 
etc.,  and  the  proprietorship  of  natural  resources  such  as 
mines,  but  also  the  right  to  an  income,  such  as  leaseholds, 
annuities,  royalties,  etc.  The  source  of  all  incomes  is  sub- 
ject to  a  process  more  or  less  akin  to  waste,  and  no  source 
of  income  may  be  regarded  as  perpetual.  Theoretically, 
therefore,  an  annual  appropriation  out  of  the  net  receipts 
is  required  for  the  replacement  of  the  capital  used  in  earn- 
ing the  income.    The  process  may  be  described  as  eliminat- 


ing  from  profits  the  element  of  capital.  Practically,  how- 
ever, there  are  Insuperable  difficulties  in  eliminating  from 
every  income  every  element  of  capital.  The  sources  of  in- 
come are  so  many  and  so  varied  that  general  principles 
suitable  on  all  occasions  and  in  every  set  of  circumstances 
cannot  be  laid  down  and  followed.  The  problem^  involves 
the  question  as  to  when  and  in  what  cases  a  deduction  is 
permissible;  upon  what  basis  the  deduction  shall  be  com- 
puted; whether  or  not  a  time  limit  to  the  recognition  of 
wastage  should  be  set;  finally,  whether  changes  in  the  value 
of  the  asset  occurring  during  its  use  affect  the  question. 

It  is  not  necessary  in  this  place  to  discuss  these  highly 
controversial  and  much  debated  questions,  or  to  concern 
ourselves  with  theoretical  definitions  of  "capital,"  "in- 
come," "profits,"  etc.  The  reckoning  of  income  and  profits 
is  at  best  an  estimate,  an  approximation — it  is  not  a  mathe- 
matical abstraction,  nor  the  result  of  theoretically  perfect 
rules  rigorously  applied.  Income  must  be,  and  can  only  be, 
what  is  usually  and  commonly  regarded  as  income.  In 
that  practical  world  with  which  alone  the  accountant 
must  deal,  there  is  no  place  for  fine-drawn  distinctions  and 
involved  mathematical  computations,  in  determining  what 
are  profits. 

In  the  case  of  mining,  however,  although  the  asset  which 
produces  the  income  (the  mine  itself)  must  necessarily 
waste  in  the  process,  we  are  able  to  avoid  the  difficult 
questions  which  arise  in  connection  with  the  wiping  out  of 
the  original  cost  or  original  capital  value  of  the  mining 
property,  as  a  charge  against  revenues  in  order  to  ascer- 
tain the  profits,  for  the  reason  that  a  special  rule  prevails, 
owing  to  the  peculiar  nature  of  mining.  The  special  rule 
is  that  the  entire  revenues  derived  from  mining  are  to  be 
regarded  as  profits,  within  the  technical  accounting  mean- 
ing of  the  term,  and  that  no  deduction  whatever  may  be 
made  from  these  revenues  in  order  to  recover  the  original 
cost  of  the  mine,  or  its  original  exchangeable  or  market 
value  at  the  time  when  it  was  acquired.  The  ultimate  loss 
which  arises  from  the  wiping  out  of  the  original  cost  or 
original  market  value  by  the  exhaustion  of  the  mineral 
deposit  Is  a  loss  of  capital,  which  loss  is  considered  separate 
and  distinct  from  a  loss  of  profits.     Even  though,   as  a 

10 


practical  matter,  the  entire  revenues  derived  from  the 
working  of  the  mine  from  the  commencement  until  it  is 
entirely  exhausted,  must  necessarily  contain  an  element  of 
capital  corresponding  to  the  original  cost  of  the  mineral 
deposit,  or  its  original  commercial  value,  this  element  of 
original  capital  is  of  an  exceptional  character  which  may 
not  be  eliminated  from  the  revenues  in  order  to  leave 
technical  profits. 

This  accounting  principle  and  rule  for  the  reckoning  of 
mining  profits  has  prevailed  invariably  in  cases  decided 
under  British  income  tax  laws.  It  was  the  accepted  view 
in  this  country  under  Federal  income  tax  laws  of  50  years 
ago,  and  in  more  modern  State  income  tax  laws.  It  is 
the  accepted  view  in  the  Western  States  where  the  value 
of  a  productive  mining  property  for  purposes  of  tax  assess- 
ment is  computed  by  capitalization  of  average  profits.  It 
was  the  principle  and  rule  accepted  by  Congress  when  the 
excise  tax  law  of  1909  was  passed,  in  which  a  tax  was 
levied  upon  the  "entire  net  income"  of  corporations.  Under 
this  Act,  as  interpreted  by  the  Supreme  Court,  the  legis- 
lative purpose  was  to  tax  the  conduct  of  business  of  cor- 
porations organized  for  profit  by  a  measure  "based  upon 
the  gainful  returns  from  their  business  operations"  {Doyle 
V.  Mitchell  Brothers  Company,  247  U.  S.,  179). 

The  prevailing   rule   was   recognized   by  the   Supreme 
Court  in  the  decision  handed  down  on  December  1,  1913, 
V  in  the  Stratton  case,  where  it  was  said: 

"It  is  true  that  the  revenues  derived  from  the 
"working  of  mines  result  to  some  extent  in  the  ex- 
"haustion  of  the  capital  *  *  *  yet  such  earnings  are 
"commonly  dealt  with  in  legislation  as  income." 

This  fundamental  rule  which  governs  the  ascertainment 
of  profits  from  mining,  by  which  no  allowance  out  of 
revenues  may  be  taken  in  respect  of  wastage  of  the  original 
capital  value  of  the  mine,  was  repeated  and  reaffirmed  in 
1916,  1917  and  1918  in  Fon  Baumhach  v.  Sargent  Land 
Company,  242  U.  S.,  503;  Goldfield  Consolidated  Mines 
Company  v.  Scott,  247  U.  S.,  126;  United  States  v. 
Biwabik  Mining  Company,  247  U.  S.,  116;  Stanton  v. 
Baltic  Mining  Co,,  240  U.  S.,  103,  and  Doyle  v.  Mitchell 
Brothers  Company,  247  U.  S.,  179. 

11 


In  Doyle  v.  Mitchell  Brothers  Company  (247  U.  S., 
179)  in  which  it  was  held  by  the  Supreme  Court  on  May 
20,  1918,  that  in  order  to  determine  the  loss  or  gain  in 
the  cutting  of  standing  timber  and  the  manufacture  of 
lumber  therefrom  during  1909  to  1912  there  must  be 
withdrawn  from  the  gross  proceeds  an  amount  sufficient 
to  restore  the  capital  value  of  the  timber  which  existed 
at  the  commencement  of  the  period  under  consideration, 
the  Court  refuted  the  argument  that  these  gains  should  be 
determined  by  the  same  principle  as  the  profits  from  min- 
ing, and  stated  that  the  two  cases  presented  '*only  a  super- 
ficial analogy." 

Under  ordinary  circumstances,  and  in  times  when  no 
income  or  profits  taxes  are  in  effect,  the  special  rule 
whereby  the  profits  derived  from  mining  are  calculated 
without  any  deduction  for  the  original  cost  or  original 
market  value  of  the  mine,  does  not  work  any  particular 
hardship,  and  its  interest  is  rather  speculative  and  theo- 
retical than  practical.  When,  however,  income  and  profits 
taxes  come  to  be  assessed,  the  long  prevailing  rule  may 
work  injustice  to  many  proprietors  of  mining  property, 
and  place  them  at  a  disadvantage  compared  with  other 
industries.  This  hardship  and  injustice  was  recognized 
by  the  Supreme  Court  in  the  Sargent  Land  Company  case, 
and  inspired  its  opinion  of  January  15,  1917,  that  in  assess- 
ing income  taxes  a  fair  argument  from  equitable  considera- 
tions arises  for  relief  from  the  severity  of  the  prevailing 
accounting  principle  and  rule  for  the  ascertainment  of  the 
profits  from  mining:     In  this  case  it  was  said: 

"A  fair  argument  arises  from  equitable  considera- 
^^tions,  that  owing  to  the  nature  of  mining  property, 
"an  allowance  in  assessing  income  taxes  should  be 
"made  for  the  removal  of  the  ore  deposits  from  time 
"to  time." 

In  recent  years  Congress  has  been  impressed  with  such 
"fair  argument  from  equitable  considerations,"  and  for 
the  purpose  of  mitigating  the  hardship  of  the  established 
accounting  rule,  a  concession  was  made  in  the  income  tax 
law  of  1913,  as  follows: 

"In  the  case  of  mines  a  reasonable  allowance  for 
"depletion  of  ores  and  all  other  natural  deposits,  not 

12 


*'to  exceed  5%  of  the  gross  value  at  the  mine  of  the 
''output  for  the  year  for  which  the  computation  is 
"made." 

In  many  cases  the  concession  offered  by  the  foregoing 
clause  of  the  1913  law  was  quite  inadequate  when  meas- 
ured by  the  actual  depletion  of  the  mineral  stock;  yet  the 
Supreme  Court  upheld  the  law,  and  approved  the  Idea 
that  the  reckoning  of  taxable  Income  was  correct,  even 
though  an  inadequate  allowance  was  made  for  the  ex- 
haustion of  the  ore  bodies.  {Stanton  v.  Baltic  Mining  Co., 
240  U.  S.,  103.)  This  was  a  consistent  decision;  for 
under  the  established  principle  and  rule  all  the  mine 
revenues  were  essentially  and  technically  profits,  and  any 
allowance  granted  therefrom  by  Congress  was  gratuitous, 
a  statutory  benefit  and  relief,  not  an  Inherent  right. 

In  the  1916  Income  tax  law  the  statutory  benefit  and 
relief  to  the  mining  Industry  was  continued,  but  the  re- 
strictive formula  was  less  rigorous.  Under  that  law  there 
might  be  a  reasonable  allowance  for  the  loss  of  capital, 
"not  to  exceed  the  market  value  In  the  mine  of  the  product 
thereof  which  has  been  mined  and  sold  during  the  year." 

In  the  Revenue  Act  of  1918  the  statutory  benefit  and 
relief  to  the  mining  Industry  was  greatly  enlarged:  the 
restrictive  formula  disappeared,  and  the  scope  of  the  capital 
sum  to  be  recovered  by  these  allowances  was  expanded  to 
admit  new  discoveries  of  ore  bodies. 

The  progressive  Improvement  In  the  position  of  the 
mining  corporations  made  by  the  Income  tax  laws  of  1913, 
1916  and  1918  was  the  result  of  concessions  made  to  the 
Industry  by  Congress,  whereby  Increasingly  liberal  allow- 
ances were  granted  to  cover  the  loss  of  capital  known  as 
depletion.  These  concessions,  however,  were  expedients 
for  counteracting  the  severity  of  Income  taxes  which  would 
be  levied,  otherwise,  upon  the  profits  of  mining  computed 
under  an  accounting  principle  and  rule  which  had  long 
prevailed,  and  which  regarded  all  mine  revenues  as  profits, 
and  none  as  assignable  to  recovery  of  original  cost  or 
capital.  These  concessions,  expedients  of  tax  legislation  do 
not  impair  the  validity  of  the  accounting  principle  and  rule. 
They  are  designed  to  counteract  Its  effect. 

It  is  true  that,  a  generation  ago,  the  prevailing  account- 

13 


ing  principle  and  rule  whereby  the  annual  profits  from 
mining  were  reckoned  without  any  deduction  for  original 
cost  or  original  market  value  of  the  mineral  deposit, 
encountered  a  measure  of  opposition  from  writers  on 
accountancy.  These  writers  could  see  no  logical  reason 
for  the  rule,  and  insisted  "that  the  mining  company  can 
no  more  legitimately  treat  the  net  annual  receipts  as  net 
profits  than  can  the  merchant  neglect  the  cost  price  of 
his  commodity,  or  the  manufacturer  disregard  the  factory 
cost  of  his  product  in  his  estimate  of  profits."  The  trouble 
with  this  reasoning  is  that  it  relies  exclusively  upon  analogy, 
and  an  analogy  which  the  Supreme  Court  has  well  char- 
acterized as  ^'superficial."  It  does  not  take  into  con- 
sideration the  peculiar  nature  of  mining,  so  concisely  and 
lucidly  pointed  out  by  the  Supreme  Court  in  the  citation 
heretofore  made  from  the  Stratton  case.  The  great 
majority  of  investments  in  mineral  deposits  do  not  even 
remotely  suggest  the  conditions  or  exhibit  the  characteristics 
of  an  ordinary  purchase  of  a  stock  of  materials  for  con- 
sumption in  productive  processes,  etc. 

The  objections  which  the  accounting  writers  of  a  genera- 
tion ago  entertained  to  the  authorized  rule  for  computing 
the  annual  profits  from  mining  without  any  deduction  for 
original  cost  of  the  mineral  deposit  were  strengthened  by 
technical  reasons.  They  were  accustomed  to  the  general 
rule  whereby  all  changes  in  the  book  value  of  certain  assets, 
implying  changes  in  the  net  wealth  which  had  occurred 
during  the  accounting  period,  must  be  reflected  in  the  profit 
and  loss  account  during  the  period.  They  could  see  no 
reason  why  a  shrinkage  in  the  cost-value  of  a  mining 
property  should  be  excepted  from  the  general  rule;  and 
could  see  no  reason  why  the  profits  of  the  period  should 
not  be  charged  with  any  such  shrinkage  which  took  place 
during  the  period.  Here  again,  their  reasoning  was  based 
upon  analogy;  an  analogy  which  did  not  exist,  essentially, 
owing  to  the  peculiar  characteristics  of  mining. 

Later,  the  technical  accounting  difficulty  arising  from  the 
concept  of  a  loss  of  original  capital,  separate  and  distinct 
from  a  loss  of  profits,  was  solved  by  Professor  Hatfield 
in  his  standard  work  on  "Modern  Accounting,"  Chapters 
XI  and  XII  on  the  subject  of  "Profits."     Realizing  that 

14 


the  general  rule  requiring  changes  in  the  book  value  of 
certain  assets  to  be  reflected  in  the  current  profit  and  loss 
account  is  not  without  exceptions,  he  posed  the  main 
question  thus : 

"Can  capital  be  lost,  without  having  such  a  technical 
loss  as  must  appear  in  the  debit  of  the  Profit  and  Loss 
account?"   (p.   199). 

Accountants  are  familiar  with  Professor  Hatfield's 
analysis  and  settlement  of  this  question,  and  we  need  not 
go  over  the  old  ground.  He  found  no  difficulty  in  accept- 
ing the  idea  that  there  can  be  a  loss  in  the  value  of  capital 
assets  which  would  affect  only  the  Capital  accounts,  and 
would  leave  the  profits  of  the  year  undisturbed.  Nor  did 
he  find  any  special  difficulty  in  disposing  of  such  capital 
losses  in  the  Balance  Sheet : 

"If  law  requires  or  permits  the  reduction  of  nominal 
capital  stock,  and  that  is  done,  the  loss  is  deducted 
immediately  from  the  Capital  account"  (p.  220). 

If,  on  the  other  hand,  the  legal  steps  necessary  to  reduce 
the  nominal  capital  have  not  been  taken,  the  shrinkages  in 
original  cost  or  original  value  of  the  assets  are  to  be  shown 
under  separate  caption  as  "Loss  on  Capital  Account,"  or 
"some  other  descriptive  term  may  be  used,  the  only  require- 
ment being  that  it  be  not  misleading"   (p.  221). 

In  commenting  upon  Professor  Hatfield's  treatment  of 
this  subject  of  capital  losses,  and  the  proper  way  of  show- 
ing them  in  the  accounts  and  the  balance  sheet,  a  recent 
text-book  advanced  the  suggestion  that  while  "the  best 
practice  compels  the  showing  of  impairment  items  as  direct 
deductions  from  capital,"  yet,  "if  a  surplus  has  been  ac- 
cumulated out  of  previous  profits,  such  surplus  constitutes 
part  of  the  capital,  and  provides  the  logical  place  for 
setting  up  the  charge."  This  suggestion  cannot  be  ad- 
mitted, however,  in  the  case  of  a  corporation;  for  the 
premise  upon  which  the  argument  rests  will  not  bear 
examination.  The  argument  is  based  wholly  upon  the 
proposition  that  surplus  "constitutes  part  of  the  capital"; 
but  this  proposition  does  not  hold  in  the  case  of  a  corpora- 
tion,   except   in    a   loose    sense.      The   term    "surplus"    is 

15 


here  used  In  its  sense  of  profits  withheld  from  distribution 
by  appropriate  corporate  action.  But,  the  status  of  such 
reserved  profits  is  entirely  different  from  that  of  the 
permanent  and  fixed  capital,  both  legally  and  in  the 
accounting  sense.  The  surplus  is  not  immovably  fixed  in 
the  business,  nor  does  It  constitute  part  of  the  permanent 
capital  of  the  corporation.  It  may  be  turned  back  into 
undivided  profits  account,  if  the  directors  so  decide;  or  it 
may  be  distributed  as  dividends  by  appropriate  action. 

11. 

Under  long  established  practice  in  the  industry  no 
entries  are  made  in  the  accounts  affecting  the  original  cost 
or  original  commercial  value  of  a  mining  property  unless 
there  is  an  actual  Impairment  of  such  original  commercial 
value  established  by  an  actual  valuation.  So  long  as  the 
original  cost  or  capital-value  is  maintained  intact,  that  is 
to  say,  so  long  as  the  known  ore  reserves  remain  at  least 
equal  to  those  known  originally,  no  entries  are  required. 
The  general  rule  is  that  in  stating  the  accounts  of  a  given 
year  any  shrinkage  of  original  cost-value  or  original  capital- 
value  of  the  mine  which  has  actually  occurred  should  be 
shown;  but  such  shrinkage  of  capital,  is  a  question  of  fact, 
dependent  mainly  upon  the  comparative  extent  and  char- 
acter of  the  delimited  ore  reserves  at  the  date  of  acquisi- 
tion, and  at  the  date  of  valuation. 

That  actual  impairment  of  the  original  cost-value  or 
original  capital-value  of  a  mining  property,  established  by 
a  valuation,  must  take  place  before  any  necessity  arises 
for  a  provision  In  the  accounts  towards  wiping  out  the 
original  value  Is  not  only  universal  practice  in  the  mining 
industry,  but  is  admitted  by  the  text-writers  who  have 
touched  on  the  subject.  The  rule  is  even  extended  to 
cover  cases  where  an  actual  shrinkage  of  original  capital- 
value  of  the  mining  property  Is  suspected,  but  cannot  be 
demonstrated  by  precise  tonnage  and  valuation  figures. 

"Where  the  amount  of  shrinkage  Is  known,  It  must 
"appear  in  the  accounts.  But  where  the  accuracy  of 
"a  valuation  is  specious,  where  the  only  ascertainable 
^^value  is  the  original  cost.  It  may  be  less  harmful  for 
"the  balance  sheet  to  show  the  cost,  indicating  that 
"it  does  not  represent  the  present  value,**  {Hatfield, 
Modern  Accounting,  p.  222.) 

16 


In  1904  a  prominent  accounting  practitioner  in  a  paper 
read  at  the  St.  Louis  Congress  of  Accountants,  and  after- 
wards quoted  in  certain  text-books,  appeared  to  take  issue 
with  the  universal  practice  and  the  accepted  accounting 
rule  whereby  extraction  of  minerals  from  a  mine  was 
disregarded  in  the  accounts  unless  an  actual  impairment  of 
cost-value  or  original  capital-value  had  taken  place,  estab- 
lished by  a  valuation.  This  writer  argued  that  provision 
should  be  made  for  exhaustion  of  sub-soil  products  even 
though  the  quantity  "known  to  be  in  a  definite  tract  at  the 
end  of  the  period  is  largely  in  excess  of  that  which  had 
been  discovered  at  the  beginning  of  the  period."  Un- 
fortunately for  the  success  of  his  argument,  it  was  an- 
nounced as  resting  upon  a  premise  which  does  not  bear 
examination.  Further,  it  admitted  the  very  necessity  of 
valuation  which  it  was  designed  to  combat: 

"The  product  taken  out  of  the  land  becomes  stock 
"in  trade  as  soon  as  it  is  extracted,  and  whatever  the 
"land  was  worth  before  its  extraction,  it  is  clearly 
^^worth  an  appreciable  amount  less  thereafter."  Dick- 
inson, Accounting  Practice  and  Procedure,  p.   174. 

The  above  premise  relies,  first,  upon  the  fancied  analogy 
between  ores  extracted  from  a  mineral  deposit,  and  the 
stock  in  trade  of  a  merchant  or  manufacturer.  This 
analogy  has  already  been  disposed  of  as  worthless  and 
unsound  in  most  cases,  or  as  the  Supreme  Court  terms 
it  "superficial."  The  premise  next  relies  upon  the  sup- 
position that  the  extraction  of  minerals  from  a  mine  in- 
variably reduces  the  "worth"  of  the  property,  and  it  is  fair 
to  assume  that  the  word  "worth"  was  used  in  its  ordinary 
significance  of  exchangeable  or  market  value.  It  is  well 
known,  however,  that  the  extraction  of  minerals  from  many 
mining  properties,  year  by  year,  does  not  result,  either 
invariably  or  even  usually,  in  a  shrinkage  in  commercial 
value.  On  the  contrary,  the  commercial  value  of  the 
mining  property  frequently  increases,  steadily  and  rapidly, 
during  a  long  term  of  years  while  extraction  is  proceeding, 
for  the  reason  that  discovery  and  development  of  new 
ore  bodies  proceeds  simultaneously. 

The  necessity  for  the  valuation  of  a  mineral  deposit  as 
an    indispensable    prerequisite    to    the    booking    of    any 

17 


shrinkage  in  the  original  cost-value  or  original  capital- 
value,  a  necessity  supported  by  universal  mining  practice 
and  admitted  by  the  text-writers,  is  a  phase  of  the  much 
discussed  question  whether  changes  in  the  market  value 
of  assets  during  their  use  have  any  bearing  upon  the 
writing  off  or  amortizing  of  the  capital  value  of  assets 
which  waste  in  the  process  of  producing  income.  The 
general  rule  is  well  established,  by  custom  and  accounting 
teaching,  that  in  the  case  of  inherently  wasting  material 
assets  such  as  plant,  machinery,  buildings,  etc.,  any  changes 
in  value  during  their  use  are  ignored,  and  the  writing  off 
or  amortizing  of  such  capital  values  proceeds  without 
regard  to  valuation.  Natural  resources  such  as  mines, 
however,  constitute  a  well-known  exception  to  the  general 
rule,  as  we  have  shown. 

This  exception  is  not  admitted  by  the  bureau,  as  we  have 
seen.  On  the  contrary,  the  bureau  has  adopted  a  rule 
whereby  the  original  cost-value  or  original  commercial 
value  of  a  mining  property  must  be  wiped  out  in  the  ac- 
counts, in  all  cases,  continuously  and  progressively  as  ex- 
traction of  mineral  units  takes  place,  regardless  of  valua- 
tion, and  regardless  of  changes  in  value  which  may  have 
occurred  during  the  accounting  or  taxable  period.  It  is 
commonly  said  that  the  bureau  relies  upon  the  decision  of 
the  Supreme  Court  in  Doyle  v.  Mitchell  Brothers  Company 
(247  U.  S.,  179)  for  justification  of  the  principle  that 
changes  in  value  of  the  mineral  deposit  during  the  account- 
ing or  taxable  period  may  be  ignored,  and  the  depletion 
allowance  made  even  though  the  value  has  increased.  The 
decision  in  that  important  case,  however,  neither  supports 
nor  condemns  the  principle  mentioned,  for  the  reason  that 
it  was  not  an  issue  in  the  case.  The  Court  decided  that 
the  timber  company,  in  determining  its  gains  or  losses 
during  a  specified  period,  was  entitled  under  the  circum- 
stances alleged  to  a  deduction  from  its  gross  revenues  "to 
restore  the  capital  value  that  existed  at  the  commencement 
of  the  period  under  consideration."  One  of  the  conditions 
which  the  plaintiff  proved,  apparently,  was  that  no  change 
in  market  value  of  stumpage  or  timber  lands  occurred 
during   the    accounting   period;    and   the    decision   of   the 

18 


Court  took  this  circumstance  into  account  expressly  in  its 
conclusion.    The  Court  said: 

^'There  having  been  no  change  in  market  values 
^^during  these  years,  the  deduction  did  but  restore  to 
"the  capital  in  money  that  which  had  been  withdrawn 
**in  stumpage  cut,  leaving  the  aggregate  of  capital 
^^neither  increased  nor  decreased!^ 

It  is,  of  course,  useless  to  speculate  what  the  decision 
of  the  Court  would  have  been  if,  during  the  taxable  period 
under  review,  the  value  of  the  timber  which  had  been  cut 
had  been  restored  by  newly  created  values,  such  as  higher 
market  prices,  or  increment  or  growth  in  the  substance. 

It  is  evident,  therefore,  that  the  reasoning  in  Doyle  v. 
Mitchell  Brothers  Company  supports  rather  than  weakens 
the  established  accounting  rule  whereby  no  entries  are  made 
in  the  accounts  affecting  the  original  cost-value  or  original 
commercial  value  of  a  mining  property,  unless  and  until 
there  has  been  an  impairment  of  such  basic  investment  es- 
tablished by  an  actual  valuation, 

III. 

In  this  discussion  we  must  keep  clearly  in  mind,  that  the 
essential  question  is  what,  if  any,  adjustment  of  invested 
capital  of  a  mining  company  is  required  in  respect  of  miner- 
als extracted  and  sold  from  the  commencement  of  mining 
operations  down  to  the  taxable  year. 

We  have  seen  that  the  bureau  in  approaching  this  sub- 
ject has  focussed  its  attention  upon  the  surplus  earnings 
of  the  mining  company  accumulated  during  the  years  prior 
to  the  taxable  year,  an  authorized  element  of  invested  capi- 
tal. The  bureau  has  proceeded  upon  the  hypothesis  that 
revenues  derived  since  the  commencement  of  operations 
from  the  extraction  of  minerals  are  not  "true"  profits  unless 
a  portion  of  such  revenues  has  been  assigned  towards  re- 
covery of  the  cost  of  the  mine,  or  its  original  invested-capi- 
tal  value.  We  have  shown  that  this  theory  is  untenable,  for 
it  is  in  conflict  with  custom  and  firmly  established  accounting 
principles  under  which  true  profits  from  mining  must  be 
reckoned  without  any  deduction  whatever  for  this  purpose. 
The  mine  revenues,  without  any  deductions  for  depletion  of 
the  mineral  stock,  being  true  profits,  and  the  accumulations 

19 


of  such  profits  being  admissible  as  invested  capital,  no  ad- 
justment thereof  in  respect  of  minerals  extracted  and  sold 
since  the  commencement  of  operations  is  permitted. 

It  follows  that  any  adjustment  of  invested  capital  re- 
quired by  the  gradual  exhaustion  of  the  mining  property 
can  be  made  only  in  the  capital  account  itself.  We  have 
shown  that,  in  the  case  of  mining  property,  no  adjustment 
of  the  capital  account  in  respect  of  removal  of  minerals  is 
permitted  by  the  accounting  rule  until  there  occurs  a  shrink- 
age in  the  value  of  the  mining  property  as  a  whole  below 
the  cost  or  original  commercial  value  thereof,  established 
by  an  actual  valuation.  In  disregard  of  this  principle,  how- 
ever, the  depletion  rule  adopted  by  the  bureau  for  adjust- 
ment of  the  cost  or  invested-capital  value  of  the  mining 
property  ignores  actual  conditions,  rejects  valuation,  and 
adopts  the  theory  that  every  unit  of  mineral  extracted  from 
the  mine  from  the  commencement  of  operations  connotes, 
necessarily  and  invariably,  an  impairment  of  paid-in  capital. 

The  conflict  between  the  rule  adopted  by  the  bureau  and 
the  established  accounting  practice  arises  from  the  effort 
of  the  bureau  to  expand  into  permanent  and  universal  ac- 
counting principles,  and  apply  retroactively,  the  statutory 
provisions  for  depletion  allowances  granted  by  recent  in- 
come tax  laws.  Under  the  income  tax  laws  of  1916,  1917 
and  1918,  as  we  have  seen.  Congress  granted  relief  to  the 
mining  industry  from  the  hardship  of  the  accounting  rule 
which  reckoned  profits  from  mining  without  any  deduction 
for  recovery  of  original  cost  or  capital  value  of  the  mine. 
The  relief  so  granted  took  the  form  of  "reasonable"  allow- 
ances, to  be  based  on  cost  or  fair  market  value  at  March  1, 
1913,  according  to  circumstances,  and  under  rules  and  regu- 
lations to  be  prescribed  by  the  department.  The  bureau 
decided,  in  interpreting  the  intent  of  Congress,  and  in  ex- 
ercising the  discretionary  and  administrative  powers  granted 
to  it  by  Congress,  that  an  administrative  rule  for  computing 
annual  allowances  for  depletion  should  be  adopted  which 
allows  a  definite  rate  for  each  unit  of  mineral  extracted  and 
sold  during  the  year,  and  which  ignores  actual  valuation  of 
the  mine  and  periodic  appraisals. 

We  see,  then  that  the  fundamental  distinction  between 
the  permanent  accounting  rules  for  booking  depletion,  on 

20 


the  one  hand,  and  the  administrative  tax  rule  for  the  ascer- 
tainment of  present-day  depletion  allowances,  on  the  other, 
is  that  the  former  requires  and  is  based  upon  periodic  valua- 
tion of  the  mining  property,  whereas  the  administrative  tax 
rule  disregards  such  valuation.  The  established  accounting 
rule  prevails  as  the  permanent  and  universal  method  of 
keeping  the  mining  accounts,  of  ascertaining  the  impairment 
of  paid-in  capital,  and  determining  the  true  profits  derived 
from  mining  operations.  The  administrative  rule  prevails 
as  the  authorized  rule  for  ascertaining  present-day  deple- 
tion allowances  for  purposes  of  income  and  profits  taxes. 
Each  of  the  two  rules  has  its  distinctive  purpose  and  its 
special  justification.  The  accounting  rule  is  justified  by  es- 
tablished custom,  precedent  and  authority.  The  administra- 
tive rule  is  justified  as  giving  efiect  to  the  intent  of  Congress 
as  expressed  in  the  particular  tax  laws  to  which  it  is  applied. 
Further:  it  is  justified  by  practical  considerations  incident 
to  tax  administration. 

It  is  evident  from  the  wording  of  the  depletion  clauses 
of  the  1916  and  1917  income  tax  laws  that  Congress  did 
not  intend  the  annual  allowances  to  be  reckoned  under  the 
permanent  accounting  rule  for  booking  depletion,  which 
rests  upon  real  impairment  of  the  cost-value  established  by 
actual  valuation  of  the  mining  property.  The  depletion 
clauses  of  those  laws  contain  a  proviso  to  the  effect  that, 
after  the  authorized  capital  sum  shall  have  been  recovered 
tax-free  through  such  allowances,  *'no  further  allowance 
shall  be  made."  This  expression  would  have  no  meaning 
if  Congress  had  intended  the  annual  depletion  allowances 
to  be  determined  under  the  accounting  rule.  The  words 
may  be  interpreted  as  contemplating  the  possibility  of  a 
depletion  rule,  for  purposes  of  tax  administration,  under 
which  the  annual  depletion  allowances,  on  the  one  hand, 
and  the  original  cost  or  original  capital-value  of  the  mineral 
deposit,  on  the  other,  need  not  expire  simultaneously,  as 
they  must  do  under  the  permanent  accounting  rule  which 
requires  periodic  appraisals. 

The  recent  income  tax  laws,  in  using  such  a  broad  and 
general  term  as  "reasonable  allowances"  for  depletion,  and 
in  directing  the  Treasury  to  formulate  rules  and  regula- 
tions, gave  to  the  bureau  the  widest  latitude  in  adopting 

21 


administrative  rules.  Under  this  broad  power  the  bureau 
rejected  the  accounting  rule  and  has  adopted  for  adminis- 
trative purposes  what  is  probably  the  only  workable  rule. 
For  it  is  evident  that  the  permanent  accounting  rule  by  re- 
quiring an  annual  valuation  of  the  mineral  deposit  in  order 
to  determine  depletion,  involves  all  the  practical  difficulties 
inseparable  from  such  appraisals;  and  its  adoption  as  a 
basis  for  administering  a  tax  measure  would  have  raised 
well  nigh  insuperable  administrative  difficulties. 

The  depletion  rule  adopted  by  the  bureau  in  1917,  while 
suitable  and  valid  for  its  purpose  of  administering  recent 
income  and  profits  tax  laws,  has  no  validity  apart  from 
that  purpose.  The  rule  is  an  artificial  product  of  income 
tax  administration,  which  has  no  bearing  or  effect  upon 
permanent  principles  of  accounting,  or  upon  the  established 
accounting  rules  for  ascertaining  the  true  profits  or  losses 
derived  from  mining.  Much  less  may  the  administrative  de- 
pletion rule  be  regarded,  as  the  bureau  appears  to  regard 
it,  as  embodying  accepted  accounting  principles  which  may 
be  applied  to  a  revision  of  the  profit  accountings  of  mining 
corporations  for  a  generation  back,  for  the  purpose  of  re- 
moving an  imaginary  taint  of  original  capital  from  the 
residue  of  their  past  profits,  and  by  this  means  deprive  them 
of  scores  of  millions  of  dollars  of  invested  capital. 

Income  and  profits,  as  was  said  by  the  Supreme  Court  in 
the  Stratton  case,  must  be,  and  can  only  be  what  are  "com- 
monly dealt  with  in  legislation"  as  income  and  profits.  They 
are  to  be  determined  by  considerations  which  have  their  in- 
fluence upon  men  of  affairs,  and  not  by  actuarial  calculations 

of  ''pure"  income,  or  subtle  mathematical  abstractions. 

****** 

In  the  foregoing  discussion  we  have  dealt  broadly  with 
the  concept  of  true  profits  from  mining,  as  an  element  of 
invested  capital.  It  must  be  kept  in  mind,  however,  that 
since  1912  there  has  been  a  statutory  concept  of  mine  in- 
come, which  differs  from  true  profits  from  mining,  various 
allowances  having  been  granted  by  Congress  in  the  tax 
measures.  The  effect  of  these  allowances  upon  invested 
capital  is  not  within  the  scope  of  this  article. 

New  York,  October  15,  1920. 

22 


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